Common stock and preferred stock are the equity classes that make up a startup’s capital structure. Founders and early employees typically hold common stock from the day the company incorporates, while investors receive startup preferred stock when they put money into a priced round. Preferred stock has contractual rights such as liquidation preference and anti-dilution protection built in.

Common stock vs. preferred stock differences come down to who can approve major decisions, how much the company founders keep as more rounds close, and who’s paid first if the company sells for less than predicted.

Below, we’ll discuss how each stock class works, where they differ on payout order and voting rights, and how the structure established at incorporation affects subsequent fundraising rounds.

Key takeaways

• Common stock sits at the bottom of the payout order. Preferred stock is repaid first.

• The equity structure a founder sets up at incorporation affects how much dilution happens in later rounds.

• Missing an 83(b) election deadline or skipping an option pool reservation are among the costliest mistakes founders make with their capitalization (cap) table.

What is common stock?

Common stock is the equity class that founders and early employees hold. When a company incorporates, the shares you issue to yourself and your co-founders are common stock by default.

Common stock sits at the bottom of the capital structure. If the company is sold or liquidated, common stock shareholders get paid only after every debt claim and every preferred stock shareholder has been paid in full. Each share carries one vote, so common stock holders elect directors and vote on major actions such as a merger or sale of company assets.

Founders who issue themselves stock at incorporation should file an 83(b) election with the IRS within 30 days. That secures an ordinary income tax on the value at grant, which is typically close to zero, instead of taxing you on the higher value at each vesting date.

What is preferred stock?

Preferred stock is the class investors receive when they put money into a priced round. Preferred stock has built-in liquidation preference. Seed and Series A funding rounds typically carry a 1x non-participating preference, which means preferred stock holders get their investment back first, then choose whether to take that return or convert to common stock and share pro rata in what’s left. Participating preferred stock (a type of preferred stock that lets investors get their money back first and then share in any remaining profits) shows up less in early rounds but more often later or in more difficult fundraising markets.

Preferred stock protects investors if the company later raises money at a lower value, helping them avoid losing as much of their ownership. The usual protection adjusts how their shares convert into ordinary shares, while a stronger type of protection (called full-ratchet anti-dilution) is usually used only when a company is in financial trouble.

What are the main differences between common stock vs. preferred stock?

Common stock vs. preferred stock diverge across four areas: payout order, voting structure, dividends, and conversion. These differences shape who controls the company day to day and who gets paid (and how much) when it sells.

Here’s how these factors play out for common stock vs. preferred stock:

• Payout order: Preferred stock is paid out before common stock. In a sale below the total invested capital, common stock holders (including founders) can end up with nothing, while preferred stock holders recover some or all of their investment.

• Voting structure: Both classes typically get one vote per share on general matters. Preferred stock often holds separate class votes on protective provisions, which gives investors a check on specific decisions regardless of how many shares founders hold.

• Dividends: Preferred stock frequently carries a dividend right, often 6% to 8% annually. That’s noncumulative in many early-stage deals, which means the dividend doesn’t accumulate if it isn’t declared each year.

• Conversion: Preferred stock automatically converts to common stock on a qualified initial public offering (IPO) or with approval from a majority of preferred stock holders. Common stock doesn’t convert into preferred stock.

How does stock structure affect fundraising?

A company’s stock structure sets how much ownership is left for new investors and how much dilution existing shareholders take on as later rounds close.

During diligence, one of the first items an investor will check is the size of the common stock pool relative to the total share count. A typical early cap table sets 10 million shares as authorized common stock, with founders issued 7 million to 8 million of those. That leaves room for an option pool, often 10% to 15% of the fully diluted share count. Investors will often ask for the option pool to be sized before their money comes in rather than after so it dilutes existing shareholders rather than the new investor.

Once a round prices, the company issues a new class, such as Series Seed Preferred or Series A Preferred, with its own par value (the minimum value assigned to a share when a company creates it), liquidation preference, and conversion terms defined in a certificate of incorporation amendment.

Investors want to see this all laid out on a cap table: a clean common stock foundation, proper vesting agreements, and filed 83(b) elections. A 409A valuation (an independent appraisal of the fair market value of the common stock) must be current before a company grants new options because it sets the strike price and keeps those grants from running into IRS penalties.

How do founders set up their stock structure at incorporation?

At incorporation, founders decide on the number of authorized shares, the par value per share (often a fraction of a cent, such as $0.00001), and how many shares go to each founder relative to their role and contribution. Many startups incorporate as a Delaware C corporation (C corp) because investors expect it and Delaware’s corporate law is well understood by startup attorneys.

An incorporation service such as Stripe Atlas can handle this formation process for new companies: it forms the Delaware C corp, issues founder common stock through its platform, generates the initial cap table, and prepares the 83(b) election paperwork founders need to file with the IRS. The service also provides a standard set of incorporation documents, including bylaws and a stock purchase agreement, built around the terms investors expect to see.

What common mistakes do founders make with stock classes?

A few common mistakes with stock classes can cost startups later.

Here’s what to look out for:

• Overissuing common stock to founders: Issuing too large a percentage to founders up front leaves too little room for an option pool and future hires. That can force a dilutive pool top-up, when a startup increases the number of shares set aside for employee stock options, right before a priced round, reducing the founders’ ownership percentage.

• Skipping or missing the 83(b) election deadline: The IRS has a strict 30-day window from the date of grant. Missing it means vesting events become taxable at each vesting date based on the stock’s value then, not its value at grant.

• Not reserving an option pool early: Waiting until a round is being negotiated to size the pool means existing shareholders absorb the dilution, not new investors.

• Misunderstanding conversion mechanics: Some founders assume preferred stock converts to common stock automatically at any exit. In practice, conversion usually requires a qualified IPO or a majority vote of preferred stock holders, with the triggers defined in the certificate of incorporation.

• Assigning uneven vesting among cofounders: Giving one founder fully vested shares while others vest over four years creates a mismatch if that founder leaves early. That founder then walks away with equity the others are still earning.

How Stripe Atlas can help

Stripe Atlas handles everything you need to legally launch your company—incorporation, Employer Identification Number (EIN), equity setup, and tax filings—so you can fundraise, open a bank account, and start accepting payments in as little as two business days, from anywhere in the world.

Join 100,000+ startups incorporated using Atlas, including startups backed by top investors like Y Combinator, a16z, and General Catalyst.

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The application takes under 10 minutes. You’ll choose your company structure, confirm your name is available, add up to four cofounders, set your equity split, and e-sign. Then Atlas takes it from there, including notifying cofounders to sign their documents electronically.

Banking and payments before your EIN arrives

Atlas files your EIN application automatically after incorporation. You don’t have to wait—Atlas enables pre-EIN payments and banking so you can start accepting payments and making transactions right away. US founders with a Social Security number are typically eligible for expedited IRS processing.

Automatic 83(b) tax election filing

Atlas files your 83(b) election for you—US and non-US founders alike—with US Postal Service certified mail and tracking to reduce personal income taxes. You’ll get a signed 83(b) election and proof of filing directly in your Stripe Dashboard, with certified mail confirmation.

World-class company legal documents

Atlas provides all the legal documents you need to start running your company, drafted by Cooley, one of the world’s leading venture capital law firms, and stores them directly in your Stripe Dashboard. These documents are designed to help you fundraise immediately and ensure your company is legally protected, covering aspects like ownership structure, equity distribution, and tax compliance.

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FAQs about common stock vs. preferred stock